How will financial markets cope with 2021? There are two shafts of light: effective vaccines and a decent Brexit deal – and we can all surely agree there is huge relief that common sense has prevailed from all quarters.
But beyond those, and beyond the prospect of a bumpy first half of the year and a decent recovery in the second, what will they make of it all?
The interaction between the world of economic performance and that of market outcomes is always uncertain and no more so that this year. It has been one of the worst for global growth – and for the US, at least, the best equity performance ever.
How will financial markets cope with 2021? Hamish McRae reveals his hopes and fears
The only way of making sense of that is to point to the industrial quantities of money created by the central banks and see they had to go somewhere. Most of that somewhere was US shares, which now account for more than half of global equity valuations. But now?
Well, none of us can know, but just to set a framework for thinking about the coming year, here are three things I am pretty sure about and three that really worry me.
First, it is pretty obvious that the UK will become more fashionable. Last year’s wave of negative headlines across the world inevitably hit investment sentiment.
This is not new. There have been many periods where the UK has been in the investment doghouse. There were the late 1970s and early 1980s; in 1992 when sterling was kicked out of the European Exchange Rate Mechanism; after the banking crash of 2008; and since the Brexit referendum of 2016.
There have also been periods of excessive adulation of UK economic management. In late 2007, when Gordon Brown was Prime Minister, sterling was trading above $2. So next year the gloom will fade. It won’t happen suddenly. People take a while to change their minds.
In any case some switch of sentiment has been feeding through in the past few weeks, especially a recognition that UK equities are the only major market that is relatively undervalued.
But by the end of the year investors will have taken a more balanced assessment of the UK. Expect the pound to be back to $1.50, and the FTSE 100 index to end the year significantly higher.
UK back in fashion: ‘Expect the pound to be back to $1.50, and the FTSE 100 index to end the year significantly higher’, says Hamish McRae
Second, interest rates will remain low throughout 2021. Whether that will turn out to be right or wrong is another matter. I happen to think ultra-easy money has become counter-productive but what any of us think is irrelevant.
The world’s central banks have such a high investment in their current policies that they are not going to change until rising inflation forces them to do so. That will come, but not to any significant extent next year.
Third, I think we will see a shift in the valuations of the so-called ‘growth’ companies vis-à-vis the so-called ‘value’ ones. So the high-tech giants of West Coast America – Apple, Amazon, Google, Facebook, Tesla et al – will be downgraded against the whole range of other enterprises that formerly topped global valuations.
These include the banks, the mining companies, the supermarkets, the consumer goods companies, indeed the whole vast array of companies that supply our daily needs.
Tech giants like Amazon could be considered less valuable compared to other stocks
Rather than thinking in terms of growth or value, think of ordinary companies being rerated against fashionable ones. That, by the way, will benefit UK and European markets in contrast to US ones.
Now the worries. The first leads on from this switch of sentiment away from high-tech America. It could get out of control. There could be a crash in the price of high-tech companies that would unsettle global asset prices everywhere.
There is a bubble now in those valuations which will have to be popped, and when that happens the damage spreads in ways that are hard to predict.
The second is the timing of the return of inflation. I was intrigued by the warning of Andy Haldane, chief economist at the Bank of England, that the Bank must have a ‘laser focus’ on inflation to stop Britain’s debt costs shooting out of control.
Yes, he is right of course. But my instinct as noted above is that this will be an issue for 2022 and beyond, rather than this coming year.
However, if that is wrong and inflation came through faster, neither the economy nor markets would be ready for the consequential climb in interest rates.
And the third concern is that there will be some political miscalculation, perhaps in China, that will disrupt the recovery.
The world needs the US and China to keep growing steadily, for they are the two big engines driving everything else. The world economy is still in a hole. Asset prices are betting on our ability to dig ourselves out of it pretty fast. Any delay would be bad for markets everywhere – and indeed for all of us in many different ways.
But at least we’re moving on from Brexit. And that’s a big plus.
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